I meant to blog about Hillary Clinton's subprime mortgage plan last week, but I got sidetracked. Luckily, Matthew Yglesias is talking about it, which reminds me that I really ought to say something.
Now one thing to note about this is that a bit contrary to campaign stereotypes, if you take this literally it betrays a certain naiveté about the way Washington works. Were a president to submit a stimulus plan with these kind of provisions in it to congress, it'd be bad news. You'd end up delaying legislative action on the overall package, and delays are a big problem with fiscal stimulus. You'd also open the door to all kinds of not-strictly-stimulus measures that various members of congress want to tack on. What Barack Obama proposed -- a much cleaner, more streamlined stimulus package that really just focuses on juicing short-term aggregate demand -- is a much better idea.
But that's if you take it literally. Things being what they are, both campaigns stimulus plans were really just smoke and mirrors, with Obama signaling that he can play grown-up technocrat and Clinton signaling that she's got a solution for every problem in her swiss army knife-like arsenal of policy measures. And while it's probably not a good idea to link the foreclosure freeze proposal to a stimulus package per se the underlying idea does seem like a pretty good one. As I wrote in my article on foreclosures there are a lot of neighborhood externalities associated with foreclosures, so it's really worth taking action to minimize them.
It may well be, but only if those measures are not actually completely insane. The good senator is proposing a temporary mortgage holiday, followed by a five-year freeze that will keep at least all subprime mortgages, and possibly all ARMs (there is some disagreement on this) at their teaser rates.
This is a terrible, horrible, no good, very bad idea. Yes, multiple foreclosures can be bad for urban neighborhoods, and it would be nice if there were some way to prevent this. But the way to prevent it is not to have the government unilaterally rewrite the terms of mortgage contracts massively in the favor of the borrowers. The teaser rates these people got can be lower than the rate on a prime fixed mortgage. This is, of course, very nice for the people who bought more house than they can afford. It will not be so nice for anyone who wants to get a subprime mortgage in the future, since this move will probably destroy that market for at least a decade or so to come. It will, of course, be very bad for anyone who happens to be a mortgage lender--aka the people the rest of us want to borrow money from in order to buy houses. This move will leave them with a lot less money to loan out to anyone else, so hello, higher mortgage rates. Higher mortgage rates, for those following along at home, generally mean lower house prices, which means that the problem of negative equity will get worse.
In other words, Senator Clinton would like to destroy the mortgage market in order to save it.
I see this problem as roughly the same problem of pharmaceutical price controls. Yes, we can help some people now, but only at the cost of hurting a lot more people in the future. Those people, of course, don't vote, either because they aren't born, or don't know who they are yet; hence, politicians often ignore them. But that's no reason that the rest of us should follow suit.
In other words, assuming this isn't just another idle campaign sop, Hillary intends to turn the next recession into the second Great Depression starting with the housing market.
The irony is that Matthew regularly ridicules McCain for admitting he knows nothing of economics. Well, I don't care much for the politics of our square-jawed Senator from the Grand Canyon state, but I do prefer the ignorami who grasp that they are ignorant to the kind who are operating under the impression that they know something.
I already knew Yglesias is an idiot, so I can't write that I am surprised.
Yancey, I'll have to disagree there, and say that your post resonates with the worst quality of Yglesias' writing, which is the dismissive scorn with which he frequently heaps upon those that don't share his assumptions about the world. To be fair, perhpas irony was your intention, but Yglesias is a smart guy who, in my view, is excessively naive about the ways of human beings in general, and human beings who seek political power in particular.
Will,
No, I was not trying to be ironic. I cannot call someone smart who believes in so much of the nonsense Yglesias writes. I probably should have written that he is extremely misguided about almost all things to do with economics, but chose, instead, to write what I really felt.
I can't believe that Hillary is serious about this. She's not stupid. This must be pandering to the economically ignorant.
Unfortunately, people tend to win elections taht way.
When she freezes mortgages at an artificially low rate does she plan to have the government loan money to lenders at an even lower rate? Where exactly are lenders supposed to get money that cheaply in today's market? Who will lend to the lenders when they know the lenders are losing money on every loan they make? Or is she just hoping that not all of the banks will be bankrupt by the end of the 5 year period?
Megan,
I'd love to see you follow this up with commentary on Obama's proposal.
We need some clarity about whom we need to save here. I don't think it's the borrowers themselves--I'm quite content to let them lose their homes. I don't think it's the lenders--you win some and you lose some. It's the communities where foreclosed homes are located--especially in those areas where you have a lot of them. I'd be interested in a government program that did nothing for homeowners, nothing for lenders, and something for communities. I'm not expert enough to know what that would be, and I don't want to create a net incentive to have foreclosed homes in one's community, but surely there are options to consider here.
Re: Where exactly are lenders supposed to get money that cheaply in today's market?
The Fed has lowered the prime interest rate (which I believe is the rate that banks pay for borrowing) to 3%. Are there any subprime loans with even a teaser rate that low? I don't think so. So the spread between what banks pay to borrow and what they have coming in remains in their favor
Also, this would only apply to a small minority of all loans. Fixed rate loans (including fixed subprimes) are already fixed so their rates are frozen for the life of the loan (duh!). And yes, this would make lenders very gun-shy about offering mortgages with teaser rates in the future-- and that's all to the good since if a person cannot afford the payment at the normal rate he should not be getting the loan! Meanwhile it will have no effect on the willingness to make fixed rate loans, or even ARMs without initial teaser rates.
Rich,
I would not do anything for the communities either. Lenders will not hold onto foreclosures- they will take what they can get for the homes eventually.
Those people, of course, don't vote, either because they aren't born, or don't know who they are yet; hence, politicians often ignore them.
It would seem there are pretty big externalities to the actions taken by our government. So doesn't it seem like it's really worth taking action to minimize them?
Make no mistake, this woman has never passed anything of significance in her lifetime. She does not think things through, she does not follow up on them, and she doesn't look for creative alternatives. She panders and politics.
DO NOT elect her.
But wait...She's only talking about freezing the sub-prime mortgage rates. She's not talking about freezing others. If those are frozen then the people who have them have time to get their finances in order (which they should have been to begin with) and then re-negotiate the terms of their loans (read:refinance).
You actually argue that it would be bad because banks wouldn't be able to lend out sub-prime loans in the future...WHAT?!!?! You actually want them to give out more money than people can afford to pay back?
Why don't we just demand that the usury laws be put back in place and say that banks must be much more discriminant in how they loan out money? If the rates go back up wouldn't that make people more responsible in what they borrow? You argue against consumer responsibility and for a company's bottom line. Let's look at logic. People who are broke, can't spend money, ergo can't boost the economy.
Banks should have been smarter in seeing this coming. They're at a huge loss with foreclosures, unless they actively re-negotiate terms with the borrowers to more manageable payments and or terms of the loans. I may not agree with all of the ideals of Hillary but geeze louise stop arguing against the backbone of the country!
jonf - The prime rate is 3% now, but will start to rise again once the economy has recovered sufficiently. Clinton's proposal calls for a five-year freeze; the rate is not going to remain this low for that long.
I think you're also missing the point about fixed-rate mortgages. The point is that banks will be offering higher fixed rates for people in the market for a new mortgage now and in the future. Yes, it would be good for them to be more careful with subprime loans, but that will happen regardless.
A freeze in rates is great for the "small minority" that would lose their homes otherwise, and horrible for everyone else. This includes current homeowners who are losing equity as well as future homeowners who can only hope that prices fall enough to offset the massive interest rates they would be expected to pay.
Wouldn't Hillary's proposal violate the Contracts Clause of the US Constitution? It's one thing to regulate future loans, but to change the terms of existing loans by fiat? That sounds like banana republic-level expropriation.
This is excellent commentary. The fact is that Lenders possess a limited amount of funds. They, being commercial entities, will chase the highest returns for their investment. If lenders fear that their investments are going to be kept artificially low (and not just "fear," but it atually happens), they will flee the market. Simple as that.
Secondly, I am honestly puzzled how Clinton intends to pull this off. Freezing interest rates is a blatant violation of Article I, Section 10 of the federal constitution. I think she needs to give some detail as the basis of her authority to interfere with contracts before she advertises such a plan.
I still have not heard word one in regard to the fact that Clinton's proposal would constitute a taking of a private property right. Thus it would require compensation to the lenders by the government in order to be constitutional. Again (as has been pointed out by others), I can't think Clinton (a Harvard edcuated attorney) and her advisors (at least one of whom is also a Harvard educated attorney) are that ignorant. The only logical conclusion is that her policy constitutes political pandering of the worst kind, the kind which assumes (rightly, I'm afraid) the ignorance of the electorate in general, and of her constituancy in particular.
It will be interesting to see if this comes up in next week's debate.
Last night, Wolfson and Axelrod were asked about it on News Hour last night. Megan, you must be channeling Axelrod. He made the same excellent argument. Basically, HRC's plan forces non-threatened borrowers to fund those threatened with foreclosure. Couldn't help but think it's like insurance - those of us who don't get sick or have an accident pay for those who do. In the end, the biggest winners will be the mortgage lenders. Are they amongst her major donors?
I don't have any hard data to back this up, but I suspect the real problem is with speculators. The media likes to put a face on the problem so they focus on families losing their homes, but many of the foreclosed homes were "investments". No one was evicted when they went into foreclosure because no one was living in them. They were purchased with the idea that they would be flipped for an easy profit. When it was apparent this wasn't going to happen, the "investors" stopped paying the mortgage and made it the bank's problem. Nothing in the world is going to get the people who speculated in real estate using sub-prime loans to keep paying their mortgages. They just aren't interested. People who were looking to flip a house aren't going to suddenly turn into long-term real estate investors just because their sub-prime mortgage is now frozen. These guys were looking to make a quick killing and that will never happen now and they have moved on to the next get rich quick scheme. That type of mind set is just not going to start renting out their sub-prime properties and be content with a making a couple of % a year return on their investment. In communities that were rife with speculation, I don't believe there is any fixing this problem.
Oh, Megan. How can you be so right and yet so wrong on the one presidential candidate who understands free market theory? Because he wants to lift the capital gains taxes on gold? Come on Megan, if free-marketers keep lining up in a circular firing squad...well, people like Clinton will be rewriting those contracts won't they?
Greg
The instant I read "freeze foreclosures", I envisaged the nightmare scenario: the new president, in her infinite wisdom, rescues people from the horrors of foreclosure. Banks, unable to enforce mortgages, cease lending under such circumstances.
Non-home owners, no matter how good their credit, cannot get mortgages. People who wish to move will face the double nightmare of a housing market without mortgages, and the inability to get new mortgages themselves.
Those people may be forced to turn down new job offer since home transactions have ground to a standstill. Businesses will be unable to fill vacant positions because the cost of relocation far outweighs any benefit in the new positions. Meanwhile, our hapless homeowners toil away in ill-fitting jobs. Heaven help them if they get laid off, which will be fairly likely as the economy grinds to a halt, because they may be forced to move and must sell their homes at huge losses without the possibility of buying a new one.
The only "winners" in this scenario are the ones who should have lost their homes in the first place, and will eventually as the economy comes crashing down because Hillary Clinton, unlike her husband, doesn't understand the basics of market economics.
This is an absurd proposal. The government has no business in changing or affecting private contracts. These mortgages are for the most part not in the hands of 'banks' like you think of it. Different tranches (or parts) are in the hands of different investors --depending on risk tolerance and positions of the tranches. The investors are throughout the world. And if our government even hints (or certainly authorizes) forestalling foreclosures or changing interest rate terms, why in the world would any investor ever buy U.S. debt again? It is bad enough that our bankruptcy courts are used to abuse lenders-investors--but to have wholesale changing of rates and terms is nothing short of populist pandering.
And while I am at it, the proposed change of the bankruptcy code to allow cram downs (reduction of interest rates) on the private contracts is equally preposterous. This will assuredly have the impact of reducing money available for home mortgages, increase mortgage rates to something commensurate to credit card debt, and further pound housing prices because less money will be available to finance transactions. Where do these leaders we elect come from that are this dumb???
Re: And if our government even hints (or certainly authorizes) forestalling foreclosures or changing interest rate terms, why in the world would any investor ever buy U.S. debt again?
UM, any move that prevents a foreclosure actually benefits investors. A libertarian purist has cause to object to that, but the investor certainly does not.
Moreover, there is no such thing as a no-risk investment (although T-bills come close). In security markets you pay you money and take your chances.
This is a good comment and better yet is J.M's entry (on Andrew's blod) and his article.
Its worth noting that with a Dem congress, a Dem prez could pass a variety of bad laws if based on 1965 liberalism.
Still, conservatives are surprisingly quiet these days, except to reflect back fondly to Reagan. (Whose ides came from Goldwater.)
J.M gives examples of good, new conservative ideas for the new century.
I agree that the proposal is misguided and would make borrowing more difficult. But more importantly, I'm wondering if you have read this: http://www.amazon.com/Alexander-Terrible-Horrible-Good-Very/dp/0689711735
It's one of my kids' favorites (and one of mine).
I don't see why you are getting your shorts in a bundle about a plan to keep teaser rates at their teaser values. ARMs with below market teaser rates are a fraudulant product. Those who offered them are no different than the Nigerian scammers. So I have no tears for the crooks who created these products.
Obviously ARMs sold with future ballon payments *cannot* be serviced. Thus the loan was worthless the day it was written--just as the stock of Pets.com was worthless from its very inception. Nevertheless, a great many of these ARMS were sold to investors just like shars of pets.com.
Having been worthless from the start, any investor who owns them should merely mark theihr value to zero and take the loss. They are out billions and they can chalk it up to the school of hard knocks.
Unlike shares of Pets.com, the collapse of these worthless pieces of paper, if allowed to proceed to foreclosures, would have huge secondary effects beyond the simple loss of investor money.
Clinton's plan, to the extent that it prevents massive foreclosures is a good idea. The damage done to the mortgage market is already an accomplished fact. Folks, we had a bubble. House prices must stay below 2005 levels in real terms for at least a decade. There is no way around that. People will need to use conventional loans to buy houses--or rent.
This whole mess was caused by deregulation. Three hundred years ago we saw what happens if you let financiers do whatever they want. After the bubble collapses regulations come in. Then people argue that we need to deregulate and we get bubbles again. Over and over again.
Nothing is ever learned.
I don't see why you are getting your shorts in a bundle about a plan to keep teaser rates at their teaser values. ARMs with below market teaser rates are a fraudulant product. Those who offered them are no different than the Nigerian scammers. So I have no tears for the crooks who created these products.
Obviously ARMs sold with future ballon payments *cannot* be serviced. Thus the loan was worthless the day it was written--just as the stock of Pets.com was worthless from its very inception. Nevertheless, a great many of these ARMS were sold to investors just like shars of pets.com.
Having been worthless from the start, any investor who owns them should merely mark theihr value to zero and take the loss. They are out billions and they can chalk it up to the school of hard knocks.
Unlike shares of Pets.com, the collapse of these worthless pieces of paper, if allowed to proceed to foreclosures, would have huge secondary effects beyond the simple loss of investor money.
Clinton's plan, to the extent that it prevents massive foreclosures is a good idea. The damage done to the mortgage market is already an accomplished fact. Folks, we had a bubble. House prices must stay below 2005 levels in real terms for at least a decade. There is no way around that. People will need to use conventional loans to buy houses--or rent.
This whole mess was caused by deregulation. Three hundred years ago we saw what happens if you let financiers do whatever they want. After the bubble collapses regulations come in. Then people argue that we need to deregulate and we get bubbles again. Over and over again.
Nothing is ever learned.
Mike Alexander wrote: ARMs with below market teaser rates are a fraudulant product. Those who offered them are no different than the Nigerian scammers.
Thanks for that wisdom (twice!), Mike. I bought my current home with a 3-year ARM in 1995. It was about 1% "below market" for the first 3 years (allowing me to afford my payments), about 1% above for the next 2 years (at which point I had gotten enough salary increases to keep up), and then I refinanced with a fixed rate in 2000, before the second 2% increment hit.
I understood what I was signing, and planned my life a few years ahead to make it work for me. I assume the lender made some money on it as well, since 1% below market - while an enticement - does not equal a loss. Independent of that, it was obviously a valuable product, and I am sad that, owing to the prevailing attitudes about choice and responsibility (of which your post is a prime example), my children will probably not have the opportunity to choose something like it.
Your "regulation" is a synonym for substituting the judgment of central planners for the free choices of individuals. The end result is to decrease freedom (as you intend) as well as the incentives for good judgment and self responsibility. Perhaps you also intend the latter.
Roger Zimmerman wrote:
I understood what I was signing, and planned my life a few years ahead to make it work for me. I assume the lender made some money on it as well, since 1% below market - while an enticement - does not equal a loss. Independent of that, it was obviously a valuable product, and I am sad that, owing to the prevailing attitudes about choice and responsibility (of which your post is a prime example), my children will probably not have the opportunity to choose something like it.
Um you were not the one being defrauded.
The purpose for financial regulation is to remove fraud. New financial products like ARMs all involve fraud in the sense that they obscure risk. They involve some sort of gimmick or "story" that somehow removes the risk and so allows risky investments to be sold as if they were safe.
The loan you got was risky, if you didn't get the raise you expected or you lost your job or interest rates rose then you might not be able to do what you did. If you loan was nonfradulent, it would have been packaged into securities having a junk grade. Had they done that they could not offer you the deal you got (they would have lost money). To make it work, they packaged your loans into AAA-rated securities.
In other words they claimed that by diversifiying they made your loan *just as safe* as if you have put 20% down and secured a traditional mortgage. Of course, the loan you made was *not* the same as a conventional mortgage, you couldn't afford to go that route, the deal they gave you was better. You recieved a benefit. But the people whose money you borrowed didn't get compensation for the extra risk involved in giving you this benefit. They got paid the same as if you had borrowed the money using a conventional mortgage.
Elaborate math models were used to show that diversification made the junk load you got just like an AAA loan. It's LTCM all over again except its a lot more widespread.
your such an incrdible person thats from the bottom of my heart.
your such an incrdible person thats from the bottom of my heart.
your such an incrdible person thats from the bottom of my heart.